The iShares S&P GSCI Commodity-Indexed Trust ETF’s (NYSEARCA:GSG) modus operandi is simple. It invests in U.S. Treasury bills and uses them as collateral for margins required for investment in futures contracts of the S&P GSCI (Goldman Sachs Commodity Index) Total Return Index. The fund’s returns are a combination of the gains delivered by the S&P GSCI Index and the interest that it earns on its Treasury securities. Note that the ETF does not pay a dividend and investors have to rely on price momentum.
The S&P GSCI index is a measure of commodity prices. It evaluates the performance of the commodity market using futures contracts of liquid commodities. Its constituents are physical commodities that are liquid and each constituent’s weight is determined by its global production numbers.
Investing in GSG is like investing in the futures contract of a basket of commodities. The ETF was launched in 2006 and since then it has had a disappointing run until Q3 2020. Commodity prices and volumes picked up from then on for a variety of reasons.
Image Source: Investing.com
On the one hand, many analysts believe that a commodity supercycle has begun, while on the other hand, some estimate that rising prices will trigger inflationary forces and lead to a fall in demand. So, well, investing in GSG now depends on how commodities are likely to fare in the medium to long term, and here is my take on whether this ETF is investable.
The Outlook for Commodity Prices
The sudden and quick rise in commodity prices happened because:
(A) COVID-19 disrupted the market, adversely impacted manufacturing and logistics, and created shortages.
(B) China contained COVID-19 more efficiently than other nations and increased its manufacturing activities. This led to a surge in commodity demand.
(C) The U.S. and Europe are aggressively vaccinating their residents and the situation has started normalizing despite the emergence of a new Coronavirus variant (Delta). As things get back to normal, the demand for goods and services is likely to escalate in the developed part of the world.
(D) The growing clamor for renewable energy and electric vehicles has led to a spike in the prices of copper, aluminum, and silver.
(E) Reputed analyst firms like Goldman Sachs published reports in January 2021 that a commodity supercycle is underway with strong structural factors backing it.
A combination of these factors sent commodity prices raging like wildfire and GSG went on to gain about 55% in the last one year.
Commodity prices have eased somewhat in May 2021 after hedge funds cut their positions. The current prognosis is that prices will stabilize because China is moving quickly to contain high prices, and harvests in the U.S. are set to increase. Moreover, analysts believe that high inflation will kill demand and correct prices sooner than later.
Image Source: My Tweet/The Lead-Lag Report
Well, we live in a crazy world. In January 2021, analysts were predicting a commodity supercycle, while today, in a space of just 5 months, they are suggesting that prices may have peaked! Who knows what can happen next!
I believe that though the world will contain COVID-19 by 2022, economic repairs will take some doing. We yet have to restore the jobs and consumer confidence that have been lost and it is not going to be easy. Therefore, I reckon that commodity prices can move up in the short to medium term, but if their price spikes are due to shortages, then price disruptions will last for a brief period. In the long run, prices will revert to their mean.
GSG’s Portfolio
Image Source: GSG’s Website
As of June 29, 2021, the S&P GSCI index had assigned the heaviest weights to three constituents: energy (58%), agricultural commodities (18%), and industrial metals (12%). Therefore, by default, GSG’s total investable assets had similar exposure to these commodity classes.
Well, commodities in the energy sector depend a lot on issues such as the OPEC’s output targets, the prospect of Iran’s oil being allowed into the market, the shift to green energy, and the rising demand for oil as the world recovers from the virus. Agricultural commodities depend on harvests; we yet have to analyze the impact of the current heatwave on harvests. Industrial metals are dependent on mining activity, economic policies of exporting countries, the pace of economic recovery, and more.
I believe that the commodity markets will continue to witness near-term disruptions and settle down by late 2021 or early 2022, or when there are indications that nations – and commodity supplies – have stabilized.
Peer Comparison
Image Source: Custom Comparison at Seeking Alpha
I compared GSG’s price momentum with two of its peers (both ETNs), the iPath S&P GSCI Total Return Index ETN (GSP) and the GS Connect S&P GSCI Enhanced Commodity Total Return ETN (GSC).
(A) GSG vs. GSP
GSG has significantly underperformed the GSP in the 6–12 months time frame, but their performances are similar in the long run (for holding periods of 3 years and over).
(B) GSG vs. GSC
GSG has outperformed GSC in the 6–60 months time frame but has lost out to it in the shorter periods shootout (1–3 months).
Summing Up
I believe that the commodity market is likely to go through a series of disruptions until countries control the virus. A majority of GSG’s holdings have significant exposure to energy, food, and industrial goods, and I estimate their demand to grow at a robust pace.
That makes me bullish on GSG in the short to medium term, with a caveat that the ETF has severely underperformed its peer GSP in the same period. GSG is best suited for short-term traders and medium-term investors who stay on top of market trends and are open to flip their portfolios when the trend reverses.
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